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It was like riding against the tide. Despite the global economic meltdown and institutional investors cutting allocations to private equity funds, Avigo Capital Partners managed to raise $150 million at the first close of its third fund, Avigo SME Fund III. The Delhi-based firm started fund raising at the worst time possible – in September 2008 – when the global banking sector had crashed.

Avigo’s Managing Partner Achal Ghai is confident of closing the fund at $250 million by second quarter of this fiscal. After the final closing of this fund, Avigo will have nearly $400 million as capital under management. While the size of first fund was $11-12 million, the second fund managed to raise $125 million in 2006.

The fund plans to continue its focus on mid-market companies, but the deal ticket sizes will be much larger now. Also, it’s now looking to do control transactions. Ghai is also concerned about depreciation of Indian rupee. VCCircle’s Madhav A Chanchani speaks to Achal Ghai on the firm’s fundraising experience and its strategy. Excerpts:

Q. How was the fundraising experience?

We started raising the fund in September 2008. We couldn’t have timed it any worse. But I must say what did really help us was the quality of institutional investors we had in our existing fund. They were very supportive and committed. Secondly, we have been working with a lot of investors including PPM (Prudential Portfolio Managers) and Siguler Guff for the last 12-14 months.

It was a tough market for raising funds but it is our positioning, track record and consistency of our strategy for the last four years that has given the confidence to our existing and new investors.

Q. How are the LPs looking at Indian private equity market now?

Very selectively. Their allocations have come down and they are very selective about which fund manager to back. The environment is very tough and obviously we need to work much harder.

Q. Are you talking to some more LPs?

Yes. About four-five LPs have already started due-diligence on us. Over the coming months, once their allocations to India become more clearer, they will look to invest.

Q. Do you see any relative increase in PE allocation towards India as, besides China, it’s one of the only economies offering 6-7% growth?

Yes. India and China are still being looked at as favourable markets. The problem with India is that the government has not managed the currency very well and the depreciation of currency is the single most negative factor as compared to China.

Q. Any change in the way your existing LPs are looking at India?

They are obviously looking at fund managers who are more risk averse and more careful, and who have a very strong presence with companies on the ground in terms of a hands-on approach. We have always had a hands-on approach, even in the boom times. The companies need a lot more handholding than ever before in difficult times.

Q. Are LPs now questioning the 2:20 structure (2% management fee and 20% share in profits for fund managers)? Is this more true for funds which are into PIPE investments?

No. Not for good fund managers. For not so good managers, yes. For PIPE investors, it is being questioned. Private equity needs huge resources and you need huge teams to work with the companies. If you are doing PIPE deals, then you need (only) four analysts and you can run the business.

Q. What will be the strategy for the new fund? Any change?

No. The strategy will be the same and we will continue with our hands on approach. We would be looking at companies with more risk-absorption capacity, therefore the bar for investment has also been raised. We may be investing in little less riskier companies as compared to two years ago. Because availability of bank credit lines, the entrepreneurs networks etc to help the businesses through tough times have become even more important now.

Q. What are the sectors that you are looking at, or are excited about?

The focus sectors do not change – industrial manufacturing and services, engineering, contracting, and infrastructure related manufacturing and services. Bulk of the investment will go into these sectors. We have a small portion of the fund, about 10-15%, through which we may look at emerging sectors like education, media, speciality retail and rural services.

Q. What kind of challenges are your portfolio companies facing?

One of the biggest challenges that everybody is facing is the expansion of working capital cycles. Companies are not getting paid on time and the banks are not supporting them. So they have readjusted their customer base to public sector, larger corporates and government agencies etc who pay on time. This is a problem consistently across the portfolio and across India as every fund manager I have talked to is saying the same thing.

Apart from in certain sectors there is slowdown in demand everywhere. Exports are a challenge, and we have not invested in textile or auto components, who are in really bad shape.

For us the number one challenge is working capital expansion and receivables. But the order book positions are pretty good in most of our companies even in these difficult times.

Q. Any companies in your portfolio that are focusing on exports?

We have two companies. One is Privi Organics, a speciality chemical firm, which has contracts of 12-18 months with major multinationals. They are doing all right because it’s very specialised. Their 78% exposure is to five multinationals which use it as a critical raw material to make detergents, soaps, perfumes, etc.

Another company is Aeroflex Industries, which manufactures steel hoses, industrial hoses, gas kits which go to refineries which are very consumable items and very specialised industry. They supply to about 30 countries and they can see reduction in volumes in certain countries. In overall revenue volumes they are doing fine. Other than these, all our portfolio companies are purely domestic focused.

Q. Will you be looking at control transactions?

Yes. We would be looking at control transactions, not buyouts. We have built a strong organisation now to handle control deals. But very selectively and not as a major focus area.

Q. Do you have controlling stake in any of your portfolio firms now?

We are likely to get a control stake in one company as a result of our convertible structure. The conversion hasn’t happened yet and they can catch up in their performance and avoid it.

Q. Do you see investment clauses getting more favourable for investors when dealing with promoters nowadays?

We have been one of the strictest funds in terms of putting downside protections and clauses, using convertible structures. In the boom time, most of the funds were willing to waive these clauses but we did not. For us, there is no change and we have every clause possible in the private equity book.

Q. That must have made closing investments in the boom time very difficult?

Yes. But we work very strongly with companies 5-6 months prior to investing to build the relationship rather than just doing deals brought in by intermediaries. Our moral is different. We help entrepreneurs manage the company, grow the company and re-organise the company.

Q. What kind of exits have you had from previous funds?

From the first fund, we have exited four out of five investments and the fifth is underway. We don’t have any exits from second fund.

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PIPE deals in India are different from the PIPE deals in developed markets. There are a lot of publicly listed companies, which ought not to be listed in the first place. In India, there are absolutely no volumes for companies which are not in Top 100-150. Essentially PIPE deals in such companies are as complicated as PE deals in India.